Capping banker bonuses simply avoids facing real bank problems

To think that capping bonuses will address moral hazard against trillions of
state aid, borders on the bizarre.

'The UK Government has taken steps to ensure a competitive financial services sector against the backdrop of an EU banking union.'Photo: ALAMY

By Mats Persson

10:30PM GMT 02 Mar 2013

With this week’s well-publicised European Union move to cap bank bonuses, the UK now faces the prospect of being outvoted on a major piece of EU financial law for the first time. This may only be the beginning.

Fundamentally, the EU’s voting system – where almost all financial laws are decided by majority voting – leaves the UK vulnerable.

While the UK accounts for 36pc of the EU’s financial wholesale market and 61pc of the EU’s net exports in financial services, it has only 72 out of 736 seats in the European Parliament and 8.3pc of votes in the Council of finance ministers.

That trade-off is acceptable as long as the UK wields significant influence over EU rules – with the City serving as a global entry point to the single market, which is still does.

In the 1990s and 2000s, this model served the UK well, with most EU laws aimed at facilitating trade.

Unsurprisingly, the focus of EU regulation started to change in 2008 with the financial crash. Of the 50 or so EU financial measures currently floating around, only a handful are aimed at boosting trade, most are about limiting or controlling financial activity in different ways – some of them fully justified.

For many EU politicians and governments it is convenient to see the financial crash – and by extension “Anglo-Saxon capitalism” – as the fundamental cause of the eurozone crisis. Bank bonuses and the financial transaction tax, they say, help tackle excessive risk-taking and, therefore, the eurozone crisis.

This is ironic, since the same governments have simultaneously resisted many measures that would address systemic threats – such as sufficiently robust capital requirements and liquidity rules and enforcing losses on creditors.

The EU has supported and approved €4.6 trillion (£4 trillion) in taxpayer-backed aid to banks over the course of the financial crisis. To think that capping bonuses will address moral hazard against trillions of state aid, borders on the bizarre. What lies behind this self-delusion? A deliberate attempt to kill the City and drive business to Frankfurt and Paris?

To some extent, but much of the motivation is, in fact, displacement activity. The tough sweeping reforms really needed to stabilise Europe’s financial sector – such as recapitalising or restructuring regional banks – often clash with regional or local politics or economics. But as politicians cannot be seen to do nothing, they take the easy route: we may not be able to create a mechanism to wind down banks but we can tell voters that we have limited the bonuses of greedy bankers. This invariably puts the City in the firing line, as that is where most of the bankers are.

This is exacerbated by a third problem – the City is a trading hub for a single currency of which the UK is not a member. The emerging union of EU banking, designed to align a supra-national currency with an interconnected banking system, creates incentives for euro states to collude in writing common financial rules that risk the City gradually being pushed “offshore”.

The European Central Bank has already demanded that transactions cleared in euros move to the eurozone, which the UK has challenged in court. If we lose, it would lead to a two-tier single market, with a protectionist eurozone bloc – and trillions of euros worth of transactions could leave London.

The UK Government has taken steps to ensure a competitive financial services sector against the backdrop of an EU banking union. But the City and the finance sector are on the front line of the EU debate. If this hub of economic activity becomes a casualty, how could a UK government still defend EU membership?